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By Lowell D. Yoder, Esq.
McDermott Will & Emery LLP, Chicago, IL
A loan made by a corporation to its parent or to an affiliate generally is not considered a taxable event. Section 956, however, provides an exception, generally treating an amount loaned by a controlled foreign corporation (CFC) to a related U.S. person as a deemed dividend to the CFC's U.S. shareholders.1
The Treasury and the IRS have provided two exceptions to the general rule of §956 which permit U.S. companies to access offshore funds on a short-term basis without triggering a deemed dividend. Notice 88-108 2 provides an exception for obligations that a CFC collects within 30 days, as long as the CFC does not have loans to related U.S. persons outstanding during the year for 60 or more days ("30/60-day exception").3 In light of liquidity needs in the United States, Notice 2008-914 expanded this exception to cover obligations that are collected within 60 days, as long as the CFC does not have loans outstanding to related U.S. persons during the year for 180 or more days ("60/180-day exception").5 The 60/180-day exception generally is available for the first three taxable years of a foreign corporation ending after October 3, 2008, but beginning before January 1, 2011.6
The IRS recently published GLAM 2009-13,7 which provides guidance concerning the application of Notice 2008-91, particularly with respect to multiple obligations of one or more CFCs. The GLAM also provides insights into the government's views on other issues involving the application of §956.
As indicated above, Notice 2008-91 applies only if a taxpayer "chooses" to rely on the 60/180-day exception. There is no requirement of a formal election. The Notice does not prescribe when or how to chose to apply the exception, which should provide taxpayers with maximum flexibility. In contrast, the Notice 88-108 exception applies automatically to a CFC if the 30/60-day tests are satisfied.8
The GLAM makes clear that choosing the application of Notice 2008-91 is done on a CFC-by-CFC basis. For example, the exception may be applied by a taxpayer to CFC1 to exclude its loans to related U.S. persons, and not applied to related CFC2, e.g., if the taxpayer desires to use §956 affirmatively to trigger a deemed dividend from CFC2. A separate CFC analysis also applies where a U.S. person holds obligations of related CFCs and those obligations, in the aggregate, are outstanding for more than 180 days during the taxable year. (This separate CFC analysis also applies for purposes of Notice 88-108.)
As indicated above, Notice 2008-91 generally applies for 2008, 2009, and 2010. The GLAM states that choosing to apply the 60/180-day exception to a CFC in one year does not require that the exception be applied in another year to the same CFC.
When counting the number of days an obligation is outstanding, the date of issuance is excluded and the date of repayment is included. For example, an obligation issued on March 15 and repaid on May 14 would be considered as outstanding for 60 days. (March 15 is not counted, but May 14 is counted.) This counting rule is described by the GLAM with respect to the 60-day limitation, but it would seem that the same counting convention should be used for purposes of applying the 180-day limitation and the 30/60-day exception provided by Notice 88-108.9
The GLAM notes that regulations provide that a CFC is deemed to have acquired property as of the date it acquires an adjusted basis in the property.10 For obligations, this would be the date the loan is made. This rule is relevant in the event a loan or other U.S. property is considered an investment in U.S. property (e.g., for purposes of determining whether such property is outstanding on the last day of the CFC's quarter-end). For example, a loan made by a calendar year CFC to a related U.S. person on December 31, 2008, that does not otherwise satisfy one of the exceptions, would be considered as outstanding on December 31, 2008 (i.e., §956 would apply to the loan for 2008), even though December 31 itself would not count as a day in the holding period under the counting convention described above.11
The GLAM explains that, for purposes of applying the 60-day requirement to a loan made in 2008 when the loan carries over into 2009, the days the loan is outstanding in 2009 must be counted. For example, a loan originated by a calendar year CFC on December 31, 2008, that remained outstanding for more than 60 days in 2009 would constitute an investment in U.S. property for 2008. Presumably, a loan made in 2010 that carries over into 2011 can qualify for the exception if it is outstanding for less than 60 days, counting the days the loan is outstanding in both 2010 and 2011.
Obligations that originate in 2008 and carry over into 2009 must be taken into account when applying the 180-day requirement to 2009. For example, to determine if a CFC meets the 180-day test in 2009, the CFC would need to include in its count the number of days that the obligation originating in 2008 remained outstanding in 2009 (but not count the days the loan was outstanding in 2008).
The GLAM quotes Regs. §1.954-1T(b)(4) and states that it will be taken into account in applying Notice 2008-91. That regulation provides that, at the discretion of the Commissioner, a CFC is considered as holding an obligation of another related CFC if one of the principal purposes for creating, organizing, or funding (through capital contributions or debt) the other CFC was to avoid the application of §956 with respect to the funding CFC. The GLAM may be alerting taxpayers that, in applying the requirements of Notice 2008-91, the IRS might carefully review the source of a CFC's funds to make the short-term loans to U.S. related persons, although there is no indication of whether the IRS has something specific in mind. A CFC that makes loans to U.S. related persons using its own funds that it otherwise had invested, either with third parties or related parties, generally should not raise a concern. In addition, the language of the regulation does not apply this conduit rule to a dividend received by a CFC that is used to fund a loan to a U.S. related person.
Where multiple CFCs make sequential loans to a U.S. borrower, under certain circumstances the IRS may view a CFC as effectively guaranteeing a U.S. obligation. Section 956 provides that a CFC is considered as holding an obligation of a U.S. related person if the CFC is a guarantor of the obligation, which obligation would be taken into account when applying the 60/180-day tests to the CFC guarantor. The GLAM indicates that this characterization might apply where a U.S. borrower is financially impaired and repayment of an obligation of one CFC within the 60 day period is contingent on a subsequent obligation to another CFC. The mere fact the CFCs are related, however, does not on its own create a presumption of a guarantee.
Finally, the GLAM states that a series of loans from one CFC must be executed independently or else periods of disinvestment will be ignored for purposes of applying Notice 2008-91. Citing Jacobs Engineering Group Inc. v. U.S,12 the GLAM provides that, should it be determined that a series of obligations constitutes successive roll-overs of a single obligation, then the periods of disinvestment will be ignored for purposes of testing the 60-day and 180-day requirements, i.e., the successive loans will be treated as one continuous loan.
Under the facts of Jacobs Engineering, in over a 2 1/2-year period a CFC made 12 successive loans to its U.S. parent to provide it with working capital. Each loan was repaid within a few months with interest. A new loan was made within a few days of the repayment of the prior loan. Applying the step transaction and substance-over-form concepts, the court held that the series of 12 short-term loans should be viewed as a single continuous loan by the CFC to the U.S. parent and thus an investment in U.S. property.13
The GLAM states that, to determine whether an obligation is independent, the analysis must consider all relevant facts and circumstances at the time of each obligation's origination. These factors may include the volatility of economic conditions and the related U.S. person's access to commercial paper markets, and a reasonable evaluation of whether these conditions will persist during the term of the loan. The evaluation should assess the availability and terms of alternative sources of outside financing to the U.S. person, as well as account for the related U.S. person's financial capacity to repay each obligation independently. It would have been helpful for the GLAM to provide more guidance on how to apply these factors.
The GLAM further states that the analysis should evaluate, within the context of the facts, the CFC's period of disinvestment between holding obligations of the related U.S. person and the reasonableness of treating each obligation as an independent obligation, citing Rev. Rul. 89-73.14 In that ruling, the Service stated that two loans will be considered as one continuous loan if the disinvestment period is "brief." For example, a CFC purchased its U.S. parent's debt obligations which were repaid in 284 days, and then 60 days later in the following taxable year the CFC purchased additional debt obligations of its U.S. parent. The ruling treated the two loans as one continuous loan outstanding at year-end.15 On the other hand, a loan outstanding for 150 days with a disinvestment period of 198 days (1:1.32) was not stepped together with the subsequent loan. Unfortunately, there is a sizable gap between the two examples, and the ruling provides little guidance on how to apply this step transaction concept beyond the examples.
To take full advantage of Notice 2008-91 — i.e., loans of 60, 60, and 59 days — the maximum disinvestment period during a taxable year could be only 62 days (1:1.033), which ratio is less than the ratio in the favorable example in Rev. Rul. 89-73. Nevertheless, at a minimum such disinvestment period should not cause the three loans to be stepped together. A contrary result would frustrate the purpose of the Notice. In addition, since the fundamental purpose of the Notice is to permit a CFC to loan funds to U.S. affiliates for up to 179 days during a taxable year to provide liquidity, and cash needs are highly unpredictable in the current economic environment, it would seem entirely appropriate to permit shorter disinvestment periods, particularly when under the circumstances another loan is important to help with an immediate liquidity problem of the U.S. company. This is supported by the GLAM which indicates that a relatively short disinvestment period (less than 60 days) is acceptable if the facts support the reasonableness of treating the obligations as independent.16
This commentary also will appear in the February 2010 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Madole, 929 T.M., Controlled Foreign Corporations — Section 956, and in Tax Practice Series, see ¶7130, U.S. Persons' Foreign Activities.
3 While Notice 88-108 literally applies to year-end obligations, GLAM 2007-0016, reprinted in BNA TaxCore (10/9/07),confirmed that the 30/60 day exception applies to obligations outstanding at the end of a quarter. See Yoder, "IRS Applies Section 956 Thirty-Day Exception to Quarters," 36 Tax Mgmt. Int'l J. 664 (12/14/07).
5 Exceptions also are provided for certain receivables arising from the sale of inventory and the provision of services. See §956(c)(2)(C); Regs. §§1.956-2(b)(1)(v), -2T(d)(2)(i)(B). See Yoder, "Improving Efficiency of Global Cash Utilization: Accelerated Payments for Inventory," 38 Tax Mgmt. Int'l J. 171 (3/13/09). Debt qualifying for these exceptions should not be taken into account when applying the 30/60- and 60/180-day requirements.
9 See Regs. §1.951-1(f) ("For purposes of sections 951 through 964, the holding period of an asset (including stock of a controlled foreign corporation) shall be determined by excluding the day on which the asset is acquired and including the day on which such asset is disposed of."). See also Rev. Rul. 70-598, 1970-2 C.B. 168 (similar rule for determining eligibility for long-term capital gain treatment).
12 79 AFTR 2d 97-1673 (C.D. Calif. 1997), aff'd, 168 F.3d 499 (9th Cir. 1999). For the years at issue, the term "obligation" did not include any indebtedness that was collected within one year from the date it was incurred.
16 The press recently reported the IRS view that, under the facts and circumstances test, a disinvestment period may be sufficient where there are fewer than 60 days between loans. In addition, an IRS official is quoted as stating that "both Jacobs Engineering and [Rev. Rul. 89-73] contemplate more than one loan from a single CFC and don't contemplate serial loans from different CFCs," i.e., those authorities should be applied on a CFC-by-CFC basis. 2009 TNT 236-5 (12/14/09).
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